The American University in Cairo

School of Business Department of Accounting

1st Mid Term Exam 305 Auditing Fall 2015
Dr Mohamed Hegazy
Question 1: For each of the following statements, state whether the statement is true (T) or
false (F) and provide your justification for false statements only:
1. In an audit area that has a higher inherent risk (Risk that financial statements may include
misstatements), it would be prudent to assign more experienced staff to that area,
2. Either an overstatement of an asset account or an overstatement of a liability account
would have the same effect on the income statement.
3. An auditor determines that a client has not accounted for a certain material item in
conformity with GAAP. This fact is prominently disclosed in a footnote to the financial
statements. The CPA does not agree with this departure from GAAP and should express
an unqualified opinion and insert a middle paragraph emphasizing the matter by reference
to the footnote.
4. If an auditor discovers that previously issued financial statements are misleading, the
most desirable approach to follow is to request that the client issue an immediate revision
of the financial statements containing an explanation of the reasons for the revision
5. If the clients balance sheet date is 31/12/2014, the audit report date is 11/3/2015, and the
date the financial statements and audit report are issued is 10/4/2015, then the auditor is
responsible for reviewing subsequent events occurring between 31/12/2014 and
10/4/2015.
6. The issuance of bonds by the client subsequent to year-end would require a footnote
disclosure in, but no adjustment to statements.
7. The letter of representation is prepared on the CPA firms letterhead, addressed to the
clients chief executive officer, and signed by the audit engagement partner.
8. When testing for contingent liabilities, the primary objective at the initial stage of the
tests is to determine the existence of contingencies

Question 2: For each of the following independent situations, indicate the type of financial
Statement audit report that you would issue, and briefly explain your reasoning. Assume that
each item is significant.
a. The management of Bonner Corporation has decided to exclude the statement of
cash flows from its financial statements because it believes that its bankers do not
find the statement to be very useful.
b. You are auditing Diverse Carbon, a manufacturer of nerve gas for the military, for
the year ended 30 September 2014. On 1 September 2014, one of its manufacturing
plants Caught fire, releasing nerve gas into the surrounding area. Thirteen people
were killed and numerous others paralysed. The company's legal counsel indicates
that the company is liable and that the amount of the liability can be reasonably
estimated, but the company refuses to disclose this information in the financial
statements.

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 c. During your audit of Cuccia Coal Company, the controller, Tracy Tricks, refuses to
allow you to confirm accounts receivable because she is concerned about
complaints from her customers. You are unable to satisfy yourself about accounts
receivable by other audit procedures and you are concerned about Tracy's true
motives.
d. On 31 January 2015, Asare Toy Manufacturing hired your firm to audit the
Companys financial statements for the year 2014. You were unable to observe the
client's inventory on 31 December 2014. However, you were able to satisfy yourself
about the inventory balance using other auditing procedures.
e. Gelato Bros. leases its manufacturing facility from a partnership controlled by the
chief executive officer and major shareholder of Gelato. Your review of the lease
indicates that the rental terms are in excess of rental terms for similar buildings in
the area. The company refuses to disclose this related- Party transaction in the notes.
f. Johnstone Manufacturing Company has used the double declining balance method
to depreciate its machinery. During the current year, management Switched to the
straight-line method because it felt that it better represented the utilization of the
assets. You concur with its decision. All information is adequately disclosed in the
financial statements.
Question 3:
A-Identify from the following statements those which should be included in the management
letter or the representation letter:
1- Completeness and availability of all minutes of meetings of stockholders, directors, and
committees of others.

2- Details of the misstatements discovered during the performance of substantive tests.

3- Availability of all financial records and related data.

4- Description of deficiencies associated with the auditors understanding, testing and assessing
of the companys internal control and reliability of its financial reporting procedures.

B- The fiscal year of the Edie Company ends on December 31. Your audit report, dated February
26, is to be delivered to the client on March 5. Listed below are events that occur or are discovered
from the date of the balance sheet to June 30 of the following year. Assume each event has a
material effect on the financial statements.

1- Jan 15 inventory is sold at a price below December 31 net realizable value.

2- Jan 20 a major customer becomes bankrupt from ongoing net losses.

3- Jan 31 the board of directors authorizes the acquisition of a company as a

subsidiary.

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 4- Feb 25 a lawsuit is decided against the company for an accident that occurred on
October 10. Damages are three times higher than estimated on December 31.

5- Feb 28 the board of directors authorizes a two-for-one stock split.

6- Mar 7 a foreign government expropriates a major foreign subsidiary following the

unexpected overthrow of the government.

Required: a) Identify the type of the event and the management decision concerning these events.

b) Indicate how the auditor would obtain knowledge of each of the above items (audit evidence)?

Question 4: The following are various activities an auditor does during audit planning.
1. Send an engagement letter to the client.

2. Tour the clients plant and offices.

3. Compare key ratios for the company to industry competitors.

4. Review managements risk management controls and procedures.

5. Identify potential related parties that may require disclosure.

6. Identify whether any specialists are required for the engagement.

7. Review accounting principles unique to the clients industry.

8. Determine the likely users of the financial statements.

For each procedure, indicate which of the first four parts of audit planning the procedure
primarily relates to: (1) accept client and perform initial audit planning; (2) understand the
clients business and industry; (3) assess client business risk; (4) perform preliminary
analytical procedures.

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Answer question 1:
1- True
2- False, overstatement of assets would result in increase in revenues and overstatement
of liability would result in decrease in income.
3- False. The auditor should issue a qualified report due to non-compliance with IFRS.
4- False. The auditor should qualify his report for beginning balances in the financial
statements or true if possible.
5- False. The auditor is responsible for period 31/12/2014 and 11/3/2015.
6- True
7- False. The representation letter is prepared on the client letter head and signed by the
companys chairman and chief financial officer.
8- True

Answer question2:
a- Non-compliance with IFRS Material qualified
b- Non-compliance with IFRS Material qualified
c- Scope restrictions material qualified.
d- No misstatements unmodified report.
e- Non-compliance with IFRS Material qualified.
f- No misstatements unmodified report.

Answer question 3:
a- 1- Representation letter 2- Management letter 3- Representation letter 4-
Management letter
b-
1- subsequent event no action / adjust - Inspection
2- subsequent event adjust - Inspection
3- subsequent event disclosure - Inspection
4- subsequent event (contingent liability) adjust confirmation attorney letter
5- subsequent event disclosure - inspection
6- no action - Inspection

Answer question 4:
1- Accept client (1)
2- Understand the clients business (2)
3- Assess clients business risk (3)/understand clients business (2). Perform analytical
procedures (4)
4- understand the clients business (2 Assess clients business risk (3)
5- perform initial audit planning (1) Assess clients business risk (3)
6- perform initial audit planning (1) understand the clients business (2)
7- understand the clients business (2)
8- understand the clients business (2)

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